The more important question perhaps is what is edge? For the trader, edge = advantage. When do the odds of a trade working go in our favor? ?Just like the card counter?s edge in blackjack, traders are better off waiting for the probability of success shifting in their favor before entering into trades.?
As a floor trader for many years on the CBOE, our edge came in the form of the bid/ask spread. We were providing the bids and offers on all of the options, and being able to buy on the bid or sell on the offer was a major advantage. Theoretically, every time we made a trade we had the opportunity to ?lock in? some value.? In addition, being able to see the order flow and emotion was a major benefit to the floor trader. As the bid/ask spread narrowed, and electronic trading took hold, the advantage of the floor trader went away.
Let?s now focus on the present, where technology has allowed just about anybody with capital and a good internet connection to trade the markets. How do you find ?edge? or advantage looking at a computer screen? As an options trader, I believe it comes in the form of understanding the flow of capital in and out of stocks and indexes. To improve your probability as an options trader, it starts with an analysis of the stock. Is it trending up, down or is it range bound? Once you have some scenario that you are trying to capture, we try to pick an options strategy or position that will give us the bias in the market we want.
This is where understanding ?implied volatility? is so important. Once you learn this concept, you start to understand the relative valuation of the puts and calls?are they cheap or expensive. There are many ways to construct a bullish, bearish, or neutral bias using options and the one chosen will be affected by whether volatility is high, low or somewhere in the middle. Options give to you the ability to speculate on direction with limited risk and small amounts of capital tied up or to take a much more non-directional approach by selling options or spreads that will expire worthless if the stock does not make a certain move. In any event, if the reason why you choose a strategy is violated, we must have a plan B, how we will react to protect our accounts.
Education can teach you how to be an expert in supply and demand, or technical analysis. Education can teach you how and when to use various options strategies and the rest is up to you having a set of rules and a plan for entry into trades, and risk management once you?re in a position. When approached as a business, the business of trading can be quite profitable.